Friday, 20 June 2014

Milk price volatility

Commodity markets have volatile prices, and its natural to seek ways of hedging the resulting risks. But you can't hedge without a counter-party. This is why retail electricity competition is weak in NZ - none of the big guys want to hedge because they are already on both sides of the market (vertically integrated, with generation and retail divisions).

What about milk? These prices don't move so quickly, but they're still very volatile as the chart shows (using GDT data). These global prices feed into the wholesale prices paid to farmers in New Zealand, and of course into the prices paid by domestic dairy processors.


Fonterra's milk price manual is set up this way. The farmgate price is (very roughly) the global price minus the cost of processing in NZ, with the calculation being made after-the-fact.

All milk is paid the same price in a season, but expectations about that price change through the season.

The obvious hedging mechanism is one I was promoting a few years ago. It involves hedge contracts between farmers and domestic dairy processors. A simple market would discover the price that suited most people: lots of parties & counter-parties would basically help each other out - end of story. I'm not going to blame Fonterra for killing off this plan, but they certainly made it clear that they wouldn't help in any way.

Now Fonterra has its own scheme, called the Guaranteed Milk Price (GMP). I don't like it because Fonterra is the only counter-party. This has two big weaknesses.

  • One is that Fonterra's executives are basically gambling with shareholder funds. As a shareholder, I'd much prefer them to be busy finding new ways to add value to our product. If they want to gamble, they should do it in their own time with their own money.
  • But also, this approach shuts out lots of other innovative smaller scale domestic processors who might greatly benefit from a fixed price.

Now I can see why Fonterra might want to make life hard for smaller scale domestic processors, but its less obvious that this is consistent with other goals one might have. Small scale dairy processors could add a lot to New Zealand's culture and economy. We do have some, but it looks like a small and marginalised sector when compared with the dominance of dairy in our agricultural production.

So maybe this is an agenda item for the upcoming review of the legislation governing Fonterra?

1 comment:

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